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SILICON IMAGE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This report contains forward-looking statements within the meaning of Section 21E of the Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These forward-looking statements involve a number of risks and uncertainties, including those identified in the section of this Form 10-Q entitled "Risk Factors," that may cause actual results to differ materially from those discussed in, or implied by, such forward-looking statements. Forward-looking statements within this Form 10-Q are identified by words such as "believes," "anticipates," "expects," "intends," "estimates," "may," "will" and variations of such words and other similar expressions. However, these words are not the only means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-Q with the SEC. Our actual results could differ materially from those anticipated in, or implied by, forward-looking statements as a result of various factors, including the risks outlined elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by Silicon Image, Inc. in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business. Silicon Image and the Silicon Image logo are trademarks, registered trademarks or service marks of Silicon Image, Inc. in the United States and other countries. All other trademarks and registered trademarks are the property of their respective owners. Company Overview Silicon Image is a leading provider of connectivity solutions that enable the reliable distribution and presentation of high-definition (HD) content for mobile, consumer electronics (CE), and personal computing (PC) markets. We deliver our technology via semiconductor and intellectual property (IP) products that are compliant with global industry standards and feature market leading Silicon Image innovations such as InstaPort™ and InstaPrevue™. Silicon Image's products are deployed by the world's leading electronics manufacturers in devices such as desktop and notebook PCs, digital televisions (DTVs), Blu-ray Disc™ players, audio-video receivers, as well as mobile phones, tablets and digital cameras. Silicon Image has driven the creation of the highly successful High-Definition Multimedia Interface (HDMI®) and Digital Visual Interface (DVI™) industry standards, the latest standard for mobile devices - Mobile High-Definition Link (MHL®), and the leading 60GHz wireless HD video standard - WirelessHD®. Via its wholly-owned subsidiary, Simplay Labs, Silicon Image offers manufacturers comprehensive standards interoperability and compliance testing services. Silicon Image was founded in 1995. We are a Delaware corporation headquartered in Sunnyvale, California, with regional engineering and sales offices in China, Japan, Korea, Taiwan and India. Our Internet website address is www.siliconimage.com. Our mission is to be the leader in advanced HD connectivity solutions for mobile, CE, and PC markets to enhance the consumer experience. Our "standards plus" business strategy is to grow the available market for our products and IP solutions through the development, introduction and promotion of market leading products which are based on industry standards but also include Silicon Image innovations that our customers value. We believe that our innovation around our core competencies, establishing industry standards and building strategic relationships, positions us to continue to drive change in the emerging world of high quality digital media storage, distribution and presentation. Our customers are product manufacturers in each of our target markets -mobile, CE, and PC. Because we leverage our technologies across different markets, certain of our products may be incorporated into our customers' products used in multiple markets. We sell our products to original product manufacturers (OEMs) throughout the world using a direct sales force and through a network of distributors and manufacturer's representatives. Our revenue is generated principally by sales of our semiconductor products, with other revenues derived from IP core/design licensing and royalty and adopter fees from our standards licensing activities. We maintain relationships with the eco-system of companies that make the products that drive digital content creation, distribution and consumption, including major Hollywood studios, service providers, consumer electronics companies and retailers. Through these and other relationships, we have formed a strong understanding of the requirements for distributing and presenting HD digital video and audio in the home and mobile environments. We have also developed a substantial IP base for building the standards and products necessary to promote opportunities for our products. Historically, we have grown our business by introducing and promoting the adoption of new technologies and standards and entering new markets. We collaborated with other companies to jointly develop the DVI and HDMI standards. Our first DVI products addressed the PC market. We then introduced products for a variety of CE market segments, including the set top box (STB), game console and DTV markets. In 2011, we began selling products in the mobile device market using our innovative interconnect core technology. In May 2011, we acquired SiBEAM, Inc., a provider of high-speed wireless communication products for uncompressed HD video in consumer electronics and personal computer applications. With this acquisition, we became a promoter of the WirelessHD standard for transmitting HD content using 60GHz wireless technology. SiBEAM's 60GHz wireless technology enables us to rapidly bring the highest quality of wirelessly transmitted HD video and audio to market. Concentrations Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For instance, our largest customer generated 38.3% and 34.5% of our revenues for the three and nine months ended September 30, 2012, respectively. In addition, our top five customers, including distributors, generated 68.3% and 65.0% of our revenue for three and nine months ended September 30, 2012, respectively, and 66.8% and 63.2% of our revenue for the three and nine months ended September 30, 2011, respectively. Additionally, the percentage of revenue generated through distributors tends to be significant, since many OEMs rely upon third party manufacturers or distributors to provide purchasing and inventory management services. Revenue generated through distributors was 40.0% and 40.1% of our total revenue for the three and nine months ended September 30, 2012, respectively, and 46.0% and 53.1% of our total revenue for the three and nine months ended September 30, 2011, respectively. Our licensing revenue is not generated through distributors, and to the extent licensing revenue increases faster than product revenue, we would expect a decrease in the percentage of our total revenue generated through distributors. 22-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect amounts reported in our condensed consolidated financial statements and accompanying notes. For a discussion of the critical accounting estimates, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Annual Report on Form 10-K for the year ended December 31, 2011. Results of Operations REVENUE Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands) Product revenue Mobile $ 38,712 $ 21,516 79.9 % $ 90,839 $ 44,647 103.5 % Consumer Electronics 17,843 22,381 -20.3 % 50,281 68,072 -26.1 % Personal Computers 5,642 5,232 7.8 % 15,559 16,486 -5.6 % Total product revenue 62,197 49,129 26.6 % 156,679 129,205 21.3 % Percentage of total revenue 84.1 % 82.3 % 81.3 % 79.6 % Licensing revenue 11,722 10,595 10.6 % 36,081 33,071 9.1 % Percentage of total revenue 15.9 % 17.7 % 18.7 % 20.4 % Total revenue $ 73,919 $ 59,724 23.8 % $ 192,760 $ 162,276 18.8 % Product Revenue The increase in product revenue was primarily due to increased demand for our mobile products offset in part by lower CE and PC revenue. The increase in our mobile products for the three and nine months ended September 30, 2012 when compared to the same periods in 2011 was primarily due to the continued success of our MHL product line. These products were introduced in the latter part of fiscal year 2010. Since then, we have seen increased shipments of these products quarter after quarter. Our MHL products represent the majority of our mobile revenue. The decrease in our CE revenue for the three and nine months ended September 30, 2012 when compared to the same periods in 2011 was primarily the result of a broad-based market shift to lower-end DTV products that incorporate our semiconductor products less frequently. Our PC revenue continues to decline as we are no longer making any investments in these legacy products. Licensing Revenue Our licensing activity is complementary to our product sales and helps us to monetize our intellectual property and accelerate market adoption curves associated with our technology and standards. The increase in licensing revenue for the three and nine months ended September 30, 2012 when compared to the same periods in 2011 is primarily the result of increased royalty revenues earned, as a result of increased units reported under the various royalty agreements and as a result of the completion of certain royalty audits. Our licensing revenue may fluctuate quarter to quarter as a result of the timing of completion of IP license arrangements or the closure of royalty audits. Revenue by Geography Based on Customers' Headquarters Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands) Asia-Pacific $ 64,537 $ 50,699 27.3 % $ 158,067 $ 138,881 13.8 % United States 5,498 4,905 12.1 % 12,675 11,823 7.2 % Europe 3,658 3,592 1.8 % 11,169 10,273 8.7 % Others 226 528 -57.2 % 849 1,299 -34.6 % Total revenue $ 73,919 $ 59,724 23.8 % $ 182,760 $ 162,276 12.6 % 23-------------------------------------------------------------------------------- Table of Contents The increase in revenues in Asia-Pacific, which includes Japan and Korea, or APAC, for the three months ended September 30, 2012, compared to the same period in 2011, was primarily due to increased demand for our MHL products. The increase in revenues in the United States for the three months ended September 30, 2012, compared to the same period in 2011, was primarily due to increased demand for our CE transmitter and receiver products and increased in licensing revenue. Revenues in Europe for the three months ended September 30, 2012, were comparable to revenues in the same period in 2011. Revenues in APAC and Europe for the nine months ended September 30, 2012 were comparable to their revenues in the same period in 2011. The increase in revenues in the United States for the nine months ended September 30, 2012, compared to the same period in 2011, was primarily due to increased demand for our MHL products, CE transmitter and receiver products and increased in licensing revenue. For the break-down of the revenue by countries based on customers' headquarters, please refer to Note 13 of Notes to Condensed Consolidated Financial Statements (Unaudited) under Part I Item 1 of this Form 10-Q COST OF REVENUE AND GROSS PROFIT Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands) Cost of product revenue (1) $ 30,760 $ 25,072 22.7 % $ 79,710 $ 67,211 18.6 % Product gross profit 31,437 24,057 30.7 % 76,969 61,994 24.2 % Product gross profit margin 50.5 % 49.0 % 49.1 % 48.0 % (1) Includes stock-based compensation expense $ 97 $ 272 $ 419 $ 586 Cost of licensing revenue $ 99 $ 144 -31.3 % $ 406 $ 644 -37.0 % Licensing gross profit 11,623 10,451 11.2 % $ 35,675 $ 32,427 10.0 % Licensing gross profit margin 99.2 % 98.6 % 98.9 % 98.1 % Total cost of revenue $ 30,859 $ 25,216 22.4 % $ 80,116 $ 67,855 18.1 % Total gross profit 43,060 34,508 24.8 % $ 112,644 $ 94,421 19.3 % Total gross profit margin 58.3 % 57.8 % 58.4 % 58.2 % Cost of Product Revenue Cost of product revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as other overhead costs relating to the aforementioned costs, including stock-based compensation expense. The increase in the total cost of revenue was primarily due to the growth in revenue volume during the same comparative periods. Product Gross Margin Our product gross margin increased primarily due to average product cost reductions exceeding average selling price reductions. The decrease in product cost is primarily due to lower wafer, assembly, packaging and testing costs, improved freight and warehouse efficiencies, better absorption of fixed and semi-variable overheads as a result of increased revenue and lower depreciation expense due to fully depreciated testers. Licensing Gross Margin Licensing gross margin during the three and nine months ended September 30, 2012 were comparable to the licensing gross margin in the same periods in 2011. 24-------------------------------------------------------------------------------- Table of Contents OPERATING EXPENSES Research and Development (R&D) Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands)Research and development (1) $ 17,848 $ 18,063 -1.2 % $ 60,067 $ 48,887 22.9 % Percentage of total revenue 24.1 % 30.2 % 31.2 % 30.1 % (1) Includes stock-based compensation expense $ 812 $ 1,636 $ 2,714 $ 2,997 R&D expense consists primarily of employee compensation and benefits, including stock-based compensation, fees for independent contractors, cost of software tools used for designing and testing our products and costs associated with prototype materials. The decrease in R&D expense for the three months ended September 30, 2012 was insignificant when compared to the same period in 2011. The decrease in R&D expense as a percentage of total revenue for the three months ended September 30, 2012 was primarily due to a 23.8% increase in total revenue for the three months ended September 30, 2012 when compared to the same period in 2011. R&D expense for the nine months ended September 30, 2012 increased primarily due to an increase in compensation related expenses as a result of the SiBEAM acquisition in May 2011, expansion in India, annual merit increases and annual bonus accruals of $5.1 million, hiring fees paid to hire 75 engineers in India of $3.0 million, and higher mask-set costs and project related expenses of approximately $4.4 million, partially offset by a decrease in consultant expense of approximately $2.2 million. Selling, General and Administrative (SG&A) Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands)Selling, general and administrative (1) $ 14,834 $ 14,521 2.2 % $ 45,167 $ 41,412 9.1 % Percentage of total revenue 20.1 % 24.3 % 23.4 % 25.5 % (1) Includes stock-based compensation expense $ 1,124 $ 1,720 $ 3,896 $ 3,941 SG&A expense consists primarily of compensation and benefits, including stock-based compensation, sales commissions, professional fees, and marketing and promotional expenses. SG&A expense during the three months ended September 30, 2012 was comparable with SG&A expense for the same period in 2011. The decrease in SG&A expense as a percentage of total revenue for the three months ended September 30, 2012 was primarily due to a 23.8% increase in total revenue for the three months ended September 30, 2012 when compared to the same period in 2011. SG&A expense for the nine months ended September 30, 2012 increased primarily due to an increase in compensation related expenses driven by annual merit increases and annual bonus accrual of $2.0 million, an increase in consultant expense of approximately $1.3 million, and an increase in event and travel expenses of approximately $1.2 million, partially offset by lower rent and relocation expenses. Amortization of Acquisition-Related Intangible Assets Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands) Amortization of intangible assets $ 496 $ 496 0.0 % $ 1,488 $ 1,089 36.6 % Percentage of total revenue 0.7 % 0.8 % 0.8 % 0.7 % The increase in the amortization of intangible assets for the nine months ended September 30, 2012 when compared to the same period in 2011was primarily due to amortization of the intangible assets acquired from the acquisition of SiBEAM in May 2011. 25-------------------------------------------------------------------------------- Table of Contents Restructuring Expense Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands)Restructuring expense $ 73 $ 360 -79.7 % $ 164 $ 1,457 -88.7 % Percentage of total revenue 0.1 % 0.6 % 0.1 % 0.9 % For the three months ended September 30, 2012, we recorded and paid restructuring expense of approximately $73,000 related to the sublease portion of quarterly rent payments on an exited facility. For the nine months ended September 30, 2012, we recorded and paid restructuring expense of approximately $256,000 related to the sublease portion of quarterly rent payments on an exited facility, offset by the reversal of accrued severance and benefits of $92,000 resulting from a change in estimates of costs incurred for prior restructuring activities. For the three and nine months ended September 30, 2011, we recorded severance benefits and exit costs incurred as a result of SiBEAM acquisition, storage business restructuring expenses and the sublease portion of quarterly rent payments on exited facilities. Interest Income and Other, net Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands)Interest income and other, net $ 323 $ 523 -38.2 % $ 1,106 $ 1,534 -27.9 % Percentage of total revenue 0.4 % 0.9 % 0.6 % 0.9 % The interest and other income for the three and nine months ended September 30, 2012 decreased primarily due to lower interest income on cash balances. Impairment of Investments in an Unconsolidated Affiliate On July 13, 2011, we purchased a 17.5% equity ownership interest in a U.S. based privately-held company for $7.5 million in cash. From July 13, 2011 through September 30, 2012, we reduced the value of our investment by an aggregate of $2.8 million ($0.6 million for the three months ended September 30, 2012) representing our proportionate share of the privately-held company's net loss during this period. In July 2012, we invested an additional $2.75 million in the form of convertible secured promissory notes. As of September 30, 2012, we have concluded that these investments are impaired and that such impairment is other than temporary; however, we will continue to hold our 17.5% interest in the privately-held company. In reaching this conclusion, we considered all available evidence, including that (i) the privately-held company had not achieved forecasted revenue or operating results, (ii) the privately-held company had limited liquidity or capital resources as of September 30, 2012, and (iii) the overall progress the privately-held company has made towards its business objectives, including the acquisition of home theater wireless speaker customers, has not progressed as previously expected. As a result of our analysis of these factors, we believe that the possibility is remote that we will exercise our call option on the investments or that we will realize any other value from these investments. As a result, we recorded a non-cash impairment charge of $7.5 million representing the carrying value of the investments as of September 30, 2012. This impairment charge was recorded in the line item equity in net loss of and impairment of investments in an unconsolidated affiliate. We have no further exposure to loss from our investment in this privately-led company given that the carrying value is zero and we have no obligation to continue to fund losses of the privately-held company. Provision for Income Taxes Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 Change 2012 2011 Change (dollars in thousands) (dollars in thousands) Income tax expense $ 2,464 $ 911 170.5 % $ 8,521 $ 4,536 87.9 % Effective tax rates 24.3 % 57.3 % 124.1 % 145.9 % Percentage of total revenue 3.3 % 1.5 % 4.4 % 2.8 % The difference between the effective tax rate and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign taxes (including foreign withholding taxes), a provision for charges in lieu of income taxes related to employee stock plans where the windfall benefit is charged to tax expense with the benefit to additional paid-in capital, and state taxes. The effective tax rates for the three and nine months ended September 30, 2011 were based on our projected taxable income for 2011, plus certain discrete items recorded during the quarter. The difference between the provision for income taxes and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign taxes (including foreign withholding taxes), a provision for charges in lieu of income taxes related to employee stock plans where the windfall benefit is charged to tax expense with the benefit to additional paid-in capital and state taxes. 26-------------------------------------------------------------------------------- Table of Contents LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION The following sections discuss the effects of changes in our balance sheet and cash flows, contractual obligations and other commitments on our liquidity and capital resources. Cash and Cash Equivalents, Short-term Investments and Working Capital . The table below summarizes our cash and cash equivalents, investments and working capital and the related movements (in thousands). September December 30, 2012 31, 2011 Change Cash and cash equivalents $ 34,178 $ 37,125 $ (2,947 ) Short term investments 111,084 124,301 (13,217 ) Total cash, cash equivalents and short term investments $ 145,262 $ 161,426 $ (16,164 ) Percentage of total assets 54.2 % 60.7 % Total current assets $ 211,817 $ 208,665 $ 3,152 Total current liabilities (53,414 ) (46,742 ) (6,672 ) Working capital $ 158,403 $ 161,923 $ (3,520 ) As of September 30, 2012, $2.9 million of the cash and cash equivalents was held by foreign subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories and prepaid expenses and other current assets, reduced by accounts payable, accrued and other current liabilities, deferred license revenue and deferred margin on sales to distributors. The net increase in current assets at September 30, 2012 as compared to December 31, 2011 was primarily due to a $14.6 million increase in accounts receivable and $8.4 million increase in inventory, partially offset by a previously mentioned $16.2 million decrease in total cash and cash equivalents and short-term investments and $3.5 million decrease in prepaid expenses and other assets. The increase in accounts receivable was primarily due to the increase in billings from increased sales over collections during the nine months ended September 30, 2012. The increase in inventory was primarily to meet the anticipated revenue levels in the three months ending December 31, 2012. The decrease in prepaid expenses and other current assets was primarily due to amortization of prepaid software maintenance. The net increase in current liabilities at September 30, 2012 as compared to December 31, 2011 was mainly due to a $5.1 million increase in accounts payable and $2.6 million increase in deferred margin on sales to distributors, partially offset by a $0.6 million decrease in accrued and other current liabilities. The increase in accounts payable was primarily due to the increased payables related to our inventory purchases. The increase in deferred margin on sales to distributors was mainly due to the increasing activities with our distributors driven by the acceleration of demand for our products while the decrease in accrued and other current liabilities was mainly attributable to the payment of 2011 bonus in the first quarter of 2012, payment of product rebates and payment of milestone to ABT. Summary of Cash Flows. The table below summarizes the cash and cash equivalents provided by (used in) in our operating, investing and financing activities (in thousands). Nine Months Ended September 30, 2012 2011 Change (Dollars in thousands)Cash provided by (used in) operating activities $ 2,996 $ (2,038 ) 247.0 % Cash provided by (used in) investing activities (2,880 ) 2,009 -243.4 % Cash provided by (used in) financing activities (3,039 ) 3,898 -178.0 % Effect of exchange rate changes on cash and cash equivalents (24 ) (59 ) 59.3 % Net increase (decrease) in cash and cash equivalents $ (2,947 ) $ 3,810 -177.3 % Operating Activities The cash provided by operating activities during the nine months ended September 30, 2012 was primarily due to increases in operating liabilities, such as accounts payable and deferred margin on sales to distributors, offset by an increase in operating assets, such as accounts receivable and inventories. 27-------------------------------------------------------------------------------- Table of Contents Investing Activities The cash used in our investing activities during the nine months ended September 30, 2012 was primarily a result of the $6.6 million cash used for certain capital expenditures, $3.5 million cash used for an investment in a privately-held company, $2.8 million cash used for investment in an unconsolidated affiliate, $1.0 million cash used for certain strategic business initiatives, and $0.9 million cash used for advances for intellectual properties, partially offset by $11.9 million net proceeds from the sales and maturities of short-term investments. During the nine months ended September 30, 2012, we sold $67.3 million and purchased $55.4 million worth of short-term investments. We are not a capital-intensive business. Our purchases of property and equipment relate mainly to testing equipment, leasehold improvements and information technology infrastructure. Financing Activities The cash used in our financing activities during the nine months ended September 30, 2012 was primarily due to $6.4 million cash used to repurchase our common stock and $2.1 million cash used to repurchase restricted stock units for minimum statutory income tax withholding, partially offset by the proceeds from issuances of common stock of approximately $5.0 million. Contractual Obligations Information regarding our operating lease obligations and other commitments is provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on our Form 10-K for the fiscal year ended December 31, 2011. There have been no material changes in our contractual obligations since December 31, 2011. Payments Due In Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years Contractual Obligations: Operating lease obligations $ 12,270 $ 749 $ 5,272 $ 3,542 $ 2,707 We are required to pay the former stockholders of ABT $590,000 in cash upon the successful release on or before November 30, 2012 of production units being developed by us which incorporate certain of ABT's technologies. Liquidity and Capital Resource Requirements Based on our estimated cash flows, we believe our existing cash and cash equivalents and short-term investments are sufficient to meet our capital and operating requirements for at least the next 12 months. |